The rate cycle is close to peaking + Sydney versus Perth

Happy Friday everyone,

Good news… inflation continues to trend down. There is still a chance rates will go up again next Tuesday, however this upwards rate cycle looks to be coming to an end. Here is my wrap of the week when it comes to the most important things to know affecting your money.

Before I look at our inflation figures, just a quick comment on the US economy. You know the old saying “when the US sneezes, Australia catches cold”, well hopefully it also works in reverse.

Overnight, US economic growth for the June quarter came in at 2.4 per cent; well above the 2 per cent expected by economists. It was only earlier this year that everyone was predicting the US economy would follow large parts of Europe and go into an economic recession.

But after last night’s figures, the US economy is running hotter than expected. The US sharemarket fell as a result to break its 14-day winning streak. If it had been up this morning it would have tied the record for the longest winning streak set in… 1897. No, I haven’t muddled up the figures… 1897.

The reason the US sharemarket wasn’t celebrating is that a hotter-than-expected economy fuels inflation and the Federal Reserve may need to continue hiking interest rates to cool it down.

But our latest inflation figures are showing our rate cycle is close to peaking

I explained in my last newsletter that after last week’s very low unemployment figure, this week’s quarterly inflation figure would play a critical role in the next RBA decision… it had to offset the tight labour market.

And it did. The June quarter CPI was 0.8 per cent and 6 per cent for the year. Economists were expecting the quarterly rate at 1 per cent and the annual rate is down 1 per cent from the previous quarter.

It turned out to be the lowest quarterly result since September 2021. Also, we can expect the next quarter’s annual rate to benefit from September 2022’s whopping 1.8 per cent result dropping out of the annual cycle.

It’s good news, but the Reserve Bank is also looking for today’s retail sales figures to be subdued as well.

Price inflation for “goods” continued to slow, but price inflation for “services” accelerated because of wage rises.

By goods, they mean price rises for things like food, household appliances, clothing and furniture has slowed.

Accelerating services inflation is being driven by rents, restaurant meals, childcare, international travel and accommodation (which is why Qantas shares are doing so well along with Flight Centre, Corporate Traveller and Webjet), plus insurance.

Anyone who is renting at the moment knows exactly how much rents are rising. If you don’t, take a look at these graphs. The rent rises are getting so bad that it seems a lot of renters are moving home or buying a property to ease the pain.

When it comes to capital cities, rental increases in Perth and Brisbane have been leading the way, but most cities are posting big rises.

Insurance, which is heading to record levels, was the other big inflation driver. So insurance companies are benefitting from increased premiums and the bonus from rising interest rates on their investment portfolios.

On my sharemarket investment program The Call (www.ausbiz.com.au) this week, listed insurance broker’s AUB and Steadfast came up for our expert panels to analyse. Their one-year and 5-year price charts are both, well, off the charts. Both are benefitting from the premium rises because their commissions are a percentage of the premium… the higher the premium, the higher their commission.

Rents look like they’ve peaked and are starting to slow

Hopefully the rent rises driving inflation are starting to ease, according to Ray White’s economist Nerida Conisbee… at least when it comes to houses.

Last month, Australian advertised house rents saw the lowest annual increase since December 2021. While the increase is still high, the pace of change is moving in the right direction. With no easing in housing supply and with the population increasing at a rapid rate, what’s driving it? And will this easing continue?  

According to Nerida, the main reason that house rents are beginning to stabilise is that affordability issues are starting to hit. An increasing number of people simply can’t afford to live on their own, or in smaller households. This means that more people are looking to share; moving in with friends, moving back home, or in with other family members.

Remember outgoing RBA Governor Philip Lowe was making this exact point a couple of months ago and was castigated for saying it.

Earlier this year the Reserve Bank looked at average household size since the 1980s on a monthly basis, utilising the ABS Labour Force Survey. It explained why there were such strong rental increases during the pandemic, despite a rapid reduction in population growth.

Boosted by higher savings rates, and a desire for more space during lockdowns, more people moved out on their own. One person households hit a peak and more people moved into smaller households. This created higher levels of household formation and the number of people per household hit an all-time low.

The analysis also explains why we are seeing rental increases starting to ease right now. In the same way households disbanded, creating lots of new houses, this trend is now reversing. More people are again living together, and average household size is starting to increase. This is creating less demand for rental housing.

Interesting, isn’t it? These are the psychological and community trends which a lot of investors don’t take into account when making decisions.

Sydney versus Perth… which offers the best property potential?

I’ll declare my bias up front. My daughter and son-in-law moved to Perth as the pandemic started and have been looking to buy after renting for a few years. They have a townhouse in Sydney and the family discussion has been around the usual questions: should you keep the Sydney property and continue renting? Or buy in Perth on a smaller scale and keep Sydney? Or sell Sydney and buy big in Perth?

We have all been there. This is part of life for a mobile family and workforce. And, of course, there are lots of individual factors to take into consideration, such as whether the move is long term, the size and ages of the family, etc, etc. No one answer fits everyone.

The instinct is to keep the property in Sydney as it’s the biggest residential market and has always shown strong growth. It has this aura of leading the national property market. So it must have the best investment potential.

Or does it?

That’s why I was naturally interested in the recent CoreLogic comparison of Sydney versus Perth for property investors. 

According to Australian Bureau of Statistics lending indicators, at a state level NSW is receiving the bulk of the interest, with investors accounting for 38 per cent of the value of new mortgage lending across the state.

At the other end of the scale, only 24.5 per cent of mortgage commitments were for investment purposes across Tasmania and 28 per cent in Western Australia. But while Perth has a lower portion of investment activity, it has the highest gross rental yield among the state capitals, at 4.9 per cent. And arguably some of the best prospects for capital gains.

The entry point to the market in Perth is also more achievable, with home values recording the lowest median dwelling value of the state capitals and prices proving to be pretty resilient through the rate hiking cycle so far… In fact, Perth is the only capital city where housing values have recovered to a new record high.

According to CoreLogic’s Tim Lawless, the fundamentals suggest Perth is a location that presents one of the best investment opportunities around the country. And yet investors aren’t very active in that marketplace.

Investors are more active in NSW, where rental yields are the lowest of any state and in Sydney the lowest of any capital city. The buy-in price is significantly higher, and arguably the prospects for capital gains could be less significant when you consider the affordability challenges across the Sydney marketplace.

It could be because of the herd mentality of investors that Sydney always appears to deliver strong property return. Or investors could be wary of the historic boom/bust cycle of Perth.

Who knows.

According to Tim, the Perth market could be a strong option for investors, as is the southeast Queensland housing market, due to strong fundamentals like higher rental yields, a lower buy-in price, and rapid rate of population growth driven by overseas and interstate migration.

Both Western Australia and Queensland have strong interstate migration, which tends to drive purchasing demand; while the strong overseas migration of other states tends to be toward rental demand.

If you're looking for capital gain, Sydney and Melbourne do have a stronger history of capital gains, but they're also relatively expensive, which could dampen capital gain opportunities going forward.

The other downside is a very low gross yield profile, with Sydney dwellings returning a gross yield of 3.1 per cent and Melbourne a gross yield of 3.5 per cent.

If you're looking for the best of both worlds, again, Perth and southeast Queensland have a higher yield profile but also, arguably, stronger prospects for capital gains. Especially considering their healthy mix of housing demand from a blend of interstate and overseas migration, along with more affordable housing prices relative to the largest capitals.

The US Nasdaq tech index has been rebalanced

If the Nasdaq index in the US has been a bit wild this week, it’s because the makeup of the index has been rebalanced.

The reason is the mega share price performance of the seven biggest US tech stocks over the last year. They’ve left the rest of the market in their wake to the point where the Nasdaq index doesn’t really reflect the performance of the whole tech sector.

On 24 July the Nasdaq 100 (NDX) underwent a “special rebalance”, with the aim of bringing down the weighting in the index of these seven stocks.

Long (llloooonnnnggg) term investing

I talk all the time about long term investing and how you need to be aware of investment cycles on overall performance. But when I talk about long term investment, I generally have performance figures over 10, 20 and even 30 years.

But what about over 200 years? Now that caught my attention this week.

Granted the performance is US-based, but I found it interesting anyway. A dollar invested in shares in 1801 would today be worth $2.33 million. That same dollar in Government bonds would be worth $2,163, in gold $4.06 and in the mighty US dollar it would be worth just 4 cents.